There is now little doubt …

Doubts remain about the health of key financial institutions — in large part because they extended a lot of credit against homes and kept far more of that credit on their balance sheets than most analysts expected (and certainly seem to have been more exposed than their regulators realized).

Many emerging economies that previously borrowed a lot now cannot borrow. They will have to cut back. That includes previously high-flying emerging economies like Dubai.

Economic activity is slowing globally — and the risk is that will slow more.

Let me give credit to Dr. Roubini (my former boss) for holding firm to his conviction that vulnerabilities were building even as it seemed, at least for a while, that the US economy would be able to shrug off a fall in investment in new homes.

The key challenge now is to guard against the risk that the current financial crisis will morph into a deep and sustained fall in economic output. Dr. Krugman mentioned a recent Goldman Sachs report (GS US Economics Analyst November 14 2008) on the US economy. I’ll plug it too. Goldman Sachs forecasts that the private sector’s financial balance — private borrowing net of private investment — will swing from a deficit of 4% of GDP in 2005 to a surplus of around 10% of GDP at the end of 2009. That means that the US private sector will go from being a net borrower to a big net saver.

The overall swing is far larger than the swing from a deficit of around 6% of GDP to rough balance that accompanied the .com crash. That makes sense. The .com crash wasn’t accompanied by a large fall in home prices — and didn’t trigger a banking crisis.

Moreover, the process has a long way to go. The private sector balance has gone from a 4% of GDP deficit in late 05/ early 06 to a surplus of around 1% of GDP in the second quarter of 2008. As a result of this fall in the private sector’s net borrowing, the US current account balance improved even though US government borrowing has gone up. But if Goldman’s forecast is right, the swing in the private sector’s balance is only about one-third over — and the improvement in the private sector’s financial balance will be a large drain on economic activity for the next year.

a) A substantial fiscal stimulus (they suggest that a $300-500 billion/ 2-3% of GDP stimulus might not be enough)
b) Aggressive GSE lending. Goldman observes that the GSEs have cut back on their lending (really lending that they support through their purchases of mortgages) since the September “Agency” crisis — something that feeds into further falls in home prices. Agency spreads remain wide.
c) The Fed could pre-commit to keep policy rates low for a long time
d) The Fed could start to buy long-term assets — starting with Treasuries, and then moving toward more risky assets — to bring long-term rates down, and generally start to deploy their less conventional policy options.

Goldman believes that the first three steps should be adopted now — and the last step should be held in reserve. That makes sense to me. I would add policy efforts to try to limit the fall in demand for US and European goods from emerging economies to Goldman’s list of near term policies. I worry a bit that the US will do too much of the heavy lifting to support global demand and emerging economies with large surpluses will do too little, helping to sustain a larger external deficit than I would like. But right now even I would argue that concerns about the path of external adjustment need to be subordinated to guarding against the risk of an enormous fall in US demand. Goldman’s analysis offers a good starting point for debating how best to try to contain the economic fallout from the current financial turmoil.

102 Comments

Posted by tyaresunNovember 19, 2008 at 9:29 pm

I agree whole heartedly with the following statement “I worry a bit that the US will do too much of the heavy lifting to support global demand and emerging economies with large surpluses will do too little, helping to sustain a larger external deficit than I would like”.

I do not agree with the statement that “I would argue that concerns about the path of external adjustment need to be subordinated to guarding against the risk of an enormous fall in US demand.”

The big question for which I have not seen any discussion is how can the USA force the emerging markets to cooperate. I am pretty sure they are not going to do it on their own. Also, I believe this is the right time. If we do not act now, we simply kicking the can down the road.

Would it be possible to restrict the US efforts to stimulate demand for non-tradeable goods only?

Would it be possible to simultaneously enact policies that will help balance trade?

When people talk about a ‘fiscal stimulus,’ of course, what they really mean is a monetary stimulus. The general category being: anything that increases the deficit.

Politicians like to say “fiscal” and think highway spending. This is because their economics people tell them that creating jobs for construction workers maximizes the number of dollars spent on consumer goods, and their campaign people tell them that the wider you “spread the wealth,” the more votes you can buy with it.

However, despite our Depression-era instincts, was this crisis caused by inadequate demand for consumer goods? It seems to me that this crisis was caused by inadequate demand for financial assets. Ie, it is a financial problem leaking into the real economy, not the other way around.

Therefore, I suggest a more drastic cure for deflation which is also likely to be more popular. Simply rebate all taxes due for the year 2008.

My plan creates a nifty little $2.5T stimulus. Realistically, this is probably about right. And, since the wealthy pay a high percentage of taxes and purchase an even higher percentage of complex structured securities, it will stimulate exactly the markets that need to be stimulated.

Posted by SimonNovember 19, 2008 at 10:33 pm

Whatever is planned an Exit Plan should be built in and pre-sold. Lack of transparency got us here. Opacity needs to be avoided to enact a successful escape.

And any escape will likely be miraculous because I haven’t yet read of anything anywhere that sees anything but a dead end ahead. By dead end I mean very high inflation, some other bubble or bubbles, escalating inescapable debt, war.

The last option is the most dreadful and the biggest reason for glastnos…

“These advantages [of exorbitant privilege] come with a cost and a responsibility. Open access to markets probably allowed US officials to drift in their response to the financial crisis. They initially mistook a solvency problem for a liquidity one. When action was ultimately forthcoming, Treasury officials failed to articulate a clear sense of principles and priorities for intervention. This ad hoc improvisation has probably stretched out and intensified the crisis. In a crisis in an emerging market economy, the sudden stop of credit to the government forces painful adjustment to be done quickly.6 These adjustments may have been painful, but a quick response tends to reduce the overall bail-out cost…

“As for responsibility, officials must recognise that investors have granted the US its reserve-currency status for reasons… t will be important to preserve these…”

Posted by KnotRPNovember 19, 2008 at 10:46 pm

A tax rebate would be blown on imports, which just prolongs (and enlarges) the problem.

A stimulus that employs construction workers would just build too much of what we already have (except for if it was targetted at cheap energy infrastructure, like solar/wind/nuclear power + grid improvements + electric cars, maybe…but we don’t probably have a lot of that kind of construction folks)….and then they’d also spend a large amount of their checks on imports.

Brad – I told you before that we’re being turned into foie gras….this is WHY….EVENTUALLY…protectionism kicks in…because anything else (except for requiring trade in goods-for-goods instead of debt-for-goods) becomes politically impossible.

We are clearly stupid, as a nation, in the sense that we’ve ignored every opportunity to halt the vendor financed force feeding, so now we’re going to learn the hard way.

Posted by gloryNovember 19, 2008 at 10:52 pm

6 In this regard, the current US situation is more akin to that in Japan in the 1990s, when policymakers delayed addressing the fundamental problem of non-performing loans and favoured half-measures for some time. The Japanese government could tap a large pool of domestic saving to fund its equivocations so that the opinion of global creditors was not relevant. The lesson is market discipline does not apply either if a nation is too big to fail or saves too much to care.

—
i dunno, it seems all rather academic until a new trez sec is announced and jan 20 rolls around… like until then it’ll be hard to witness the firepower of a fully armed and operational battle station fiscal stimulous! (with the gov’t able to borrow at zero, altho w/ deflation, they may have to use the force 😉

Posted by KnotRPNovember 19, 2008 at 10:54 pm

Maybe….if we’re lucky….someone will figure out how to transition us to (Buffett’s Squanderville story?) goods-for-goods trade model, and stomp out further debt-for-goods transactions for as long as they are unreasonably out of balance on net. Global trade only works if it’s trade in real goods for real goods….trading debt for goods with no potential for quid pro quo sales is just a fantastic way to crush those whom you wish to sell to….it’s only useful for making foie gras.

Equities are falling because companies are running out of working capital. The corporate markets are dysfunctional. Risk aversion by portfolio managers and investors has either eliminated demand or raised the cost of capital.

One way to increase demand in the corporate markets would be to exempt corporate interest payments from some level of taxation. The amount and duration would need to be structured, but providing an incentive for participants to renter and start buying again is key to any solution. Maybe demand can be stimulated on an after tax basis and money would begin to flow again.

Posted by TouristNovember 19, 2008 at 11:37 pm

Brad,

So your solution for private sector insolvency is to issue more debt, thereby, insuring US sovereign debt default? And why should anyone pay any attention whatsoever to recommendations coming out of Goldman regarding how to fix the financial nightmare given the fact that they played a leading role in creating the situation in the first place.

Let’s hope that Congress doesn’t actually listen to your advice. Regardless, the debt markets will make it clear who is running the show.

Posted by ChidambaramNovember 19, 2008 at 11:40 pm

I typed this up for Alfred but couldn’t post it earlier .. excuse the off topic comment.
Alfred:
Brad holds a position that China’s sell off of Agencies contributes to instability. At the same time he has consistently maintained that China should allow the RMB to strengthen against the dollar, and this position has not changed much.
These are two diametrically opposite positions. The only reason why any taxpayer funded institution in China would buy any dollar denominated security is to peg the RMB to the dollar. If China were to buy large volumes of Agencies it would automatically weaken the RMB against the dollar.
China has two simple policy objectives: one is to preserve the value of their forex reserve and the other is to move away from export driven growth.
These two conflicting objectives create several dependencies on success on the diplomatic front before they can give effect to any transformation in the USD exchange rate.
China has huge needs to import oil and other commodities and it has to ensure that this import will be possible without the large USD reserve that it has now. China has been attempting to strike bilateral trade deals around the world, from Russia, to some of the North African countries, to Costa Rica, etc which will ensure that it is able to make payments for imports in some currency other than the dollar. To this end China has been willing to provide dollar financing to some of these countries.
Similarly, China has been willing to provide dollar financing internationally on a multilateral basis without conditions to assuage the ongoing crisis. But China’s demand is that this should happen through an enlarged IMF. Secondly, China would like to have a bigger ownership and say in the IMF if it were to be expected to finance rescue efforts other countries. If this demand is not met, they would prefer to focus on taking care of their domestic economy, naturally.
Failure of the lame duck administration to negotiate a sufficiently acceptable role for China in international affairs at the G-20 summit has ensured that China will not take any actions to help any foreign country out of the crisis unless it’s getting something acceptable in return on a bilateral basis.

Actually, I think the 1972-1975 crises was worse than this one, and the 1981-1983 recession was almost as bad.

Chidam: Similarly, China has been willing to provide dollar financing internationally on a multilateral basis without conditions to assuage the ongoing crisis. But China’s demand is that this should happen through an enlarged IMF. Secondly, China would like to have a bigger ownership and say in the IMF if it were to be expected to finance rescue efforts other countries. If this demand is not met, they would prefer to focus on taking care of their domestic economy, naturally.

This isn’t true. China hasn’t been willing to lift a finger to help anyone else through dollar financing, and there is no interest that I can see on the part of China for more of a voice on the IMF or the World Bank. The only situation where I can imagine China undertaking a rescue effort is if someone could make a case that China’s national vital interest depends on it.

What I think is happening is that you are seeing hedge fund deleveraging. Some hedge fund with lots of losses figured that today would be a good day to dump their stocks. Anyway, I’m fairly optimistic, because I don’t see A->B->C-> (the world ends). Suppose the Dow goes down to 5000, then what?

Right now is probably a good time to go bargain hunting, look for businesses with stable cash flow, lots of cash, selling some sort of product that people want or need even in bad times. You have to do this on your own, since if someone mentions a company on the net, it’s too late.

I should point out that all of this market volatility is extremely profitable for the Wall Street firms that are still around. Everyone time someone buys or sells a share of stock, someone is making commission off of it, and when the Dow goes up 500 one day and down 500 the next, that’s a lot of commission.

trickle up approach rather than trickle down approach.
why give loans to aig. give the loans directly to consumer. money given will find the way to banking system again. this trickle up approach.
it helps the main street. bailouts to financial companies gives these financial managers free money since they pay their debt back and dont give to consumer.
this is a govt backed steal to bankers and common people suffer.
bankers have hijacked the govt at all levels

Posted by ChidambaramNovember 20, 2008 at 12:20 am

Brad:
But right now even I would argue that concerns about the path of external adjustment need to be subordinated to guarding against the risk of an enormous fall in US demand.

Brad thanks a lot for this understanding which is much closer to patriotism and practicality.

Brad:
Goldman’s analysis offers a good starting point for debating how best to try to contain the economic fallout from the current financial turmoil.

This is even more wonderful. Your blog site provides extremely accurate analysis and data whereas you leave much to be desired in terms of actionable suggestions and solutions.

It’s rare to find intellectual rigor such as yours from any of the other so called economics pundits.

Dr. Roubini might have been your ex boss but with all due respect, right now he’s just another fear monger out to collect big TV channel fees for needlessly alarmist and factually inaccurate prognostications.

His sensationalism creates more TV channel eyeballs which the channel then distracts to advertising revenue, so ultimately it’s the TV channel viewers who’re paying his fees.

All the Washington policy makers till now must’ve been gloating in glee at his comments as they try to persuade the taxpayers on ever increasing bailouts. But my bet is that come January 20, you will no longer see Dr. Doom on any of the major TV channels.

Massive amounts of resources have been have been misallocated. There is no way to avoid the economic pain this implies. All these wonderful ploys that make economists seem important prevent the necessary price adjustments & prolong the misery a la Roosevelt in the Great Depression & Japan even now.

The Japanese are suggesting that we should do any further borrowing with bonds denominated in yen.

This is the sort of thing that got Argentina into trouble.

_____________

Chidambaram, Roubini is telling it as he sees it. He’s a very honorable man, and he’s been right. He deserves respect.

Posted by MoopheusNovember 20, 2008 at 12:45 am

All things considered, Goldman Sachs wold not be my first choice of advisors. Recommending “Agresive GSE lending” seems to be saying “let’s try to keep the housing bubble from deflating completely with more of the loose lending that got us here in the first place. Only this time it’ll be the taxpayers holding the bag, and not us.” The only thing that can stop the house prices from falling further at this point would be some serious wage inflation, and I don’t see that happening anytime soon. Who benefits, really, from trying to keep house prices at still fairly unaffordable levels? Not potential buyers, that’s for sure.

Posted by Lyle BNovember 20, 2008 at 1:02 am

“The Japanese are suggesting that we should do any further borrowing with bonds denominated in yen.”

Charles, could we have a reference for this? Which Japanese made this suggestion? When? Where?

Posted by calmoNovember 20, 2008 at 1:03 am

I wonder at what point 2fish loses his equanimity.
For those of us who spend inordinate hours in front of monitors, we might expect some figure for the DOW. 5000?
But not all of us are investors. Some Americans do not really participate in what McCain called “wealth creation”. This realization is in the pipe now and I expect it to grow over the next few quarters…a real test of our mettle.
The unemployment stats are not as accurate as one might wish, but in my view it does not take many unemployed young men to create a serious social problem.

Posted by JKHNovember 20, 2008 at 1:24 am

“But if Goldman’s forecast is right, the swing in the private sector’s balance is only about one-third over — and the improvement in the private sector’s financial balance will be a large drain on economic activity for the next year.”

I wish you would emphasize what this means for all those who are terrified that foreigners are going to have to finance a large fiscal deficit.

The stimulus needs to be $ 1 trillion. For starters.

Posted by zanonNovember 20, 2008 at 1:28 am

KnotRP: I don’t know why you think a tax rebate will be spent on imports. The US does not import that much of GDP.

Moldbug is right–instead of essentially an industrial policy that picks winners and losers, rewards lobbying, and keeps zombie firms in existence (large chunks of the US financial sector, AIG, GM, Ford, Chrysler, and in ’09 the airlines etc.) it would be better if the stimulus was went straight to consumers. An even faster way than a tax free ’09 would be to simply have the Government pick up the tab for FICA starting… now. Consumers would get more $ in their pocket and could spend it on what the want and/or repair their household balance sheet faster. It’s a much more direct way to get to what we all know is the end game: larger government deficit, healthier household balance sheet.

Posted by MakeMeTreasurySecretaryNovember 20, 2008 at 1:32 am

Brad,

It would be amazing if the private sector could switch to such a big surplus. I have some questions and I would be grateful if you could give me some answers:
1. Is the private sector households and businesses? How much of this suprlus is expected to come from the household sector? What savings rate would that be?
2. How will such a surplus be achieved if not through massive deflation? On the whole, households are barely making ends meet and a big chunk of their expenses are fixed (mortgage and other debt payments, health care, tuition). Major changes will have to take place for the household sector to switch to a 1980-like savings rate. Would such changes be politically palatable?
3. With such a big surplus, would you not expect that the US dollar should strengthen further and interest rates should drop even lower?

Posted by JKHNovember 20, 2008 at 2:03 am

Moldbug,

Your general category of monetary stimulus flows from a consolidated view of the USG/Fed balance sheet, I think. Deficits and debt are an extension of monetary “sterilization” in this sense.

But the difference between monetary and fiscal stimuli can still be mapped to the difference between asset monetization and income creation, or balance sheets and income statements. A true $ 1 trillion fiscal stimulus will create $ 1 trillion in GDP and GDI (income), with knock-on effects (i.e. “multiplier” effects). $ 1 trillion in TARP or central bank buying of treasuries doesn’t do this – at least not directly.

I think that Goldman leaves out the most important measue that can be taken, which is to resolve the ambiguity around F&F. They either must be truly nationalized and turned into a going concern gain or put on a debt recovery footing (essentially what may have ben the original idea of having a conservator). It is incomprehensible that the government allows such a crazy pro-cyclical mode of operation in businesses that, should (looking at their origins, location of oversight outside the mainstream of financial sector regulation and apparent function in recent gvt policy after the drying up of truly private sources of mortgage financing.

I would be in favour of having the conservator going on (i.e. protecting the interests of creditors) but only if an alternative source of plentyful and cheap housing finance is made available, for instance by stretching GNMA.
That would avoid the politically unacceptable situation of either expropriating F&F’s privately held franchise (for how much longer, sooner or later thry will be truly insolvent) or rewarding after all, the people who made such a mess, first by doing the bidding of politicians when politicians were not prepared to commit real state money and second by suddenly stopping lending when questions arose over their financial soundness. I am still amazed that this otherwise so financially irresponsible government has not acted in the best interests of the US population at large.

Posted by Lyle BNovember 20, 2008 at 2:09 am

I found the reference – a post on Naked Capitalism, based on an article in Asia Times.

The idea of issuing foreign currency-denominated US Treasures is not new. The Jimmy Carter administration, buffeted by the two oil crises of the 1970s, sold “Carter bonds”, denominated in German marks and Swiss francs, in 1978 to attract foreign investors into Treasuries.

“The US will be forced to issue foreign currency-denominated US Treasures in its hour of need,” said Mizuno. “The US cannot finance its deficit by itself. The US financial system cannot survive without foreign investors. We will see ‘Obama Bonds’ in the future.”

Posted by ChidambaramNovember 20, 2008 at 3:22 am

Our main aim is not to see what lies dimly at a distance but to do what lies clearly at hand.
– Thomas Carlyle
I’m not questioning the personal honor level of Dr. Roubini or anybody else but I do have doubts about the usefulness and objectivity of the activities of several economists during this crisis.
All these economists are there only to provide useful and actionable suggestions to policy makers, and to provide useful information and analysis to market participants to help with their expectations.
If an economist is employed by a taxpayer funded organization, then she should focus on policy suggestions which can mitigate economic woes.
A privately occupied economist should on the other hand provide useful inputs to market participants, depending on what the requirements for those inputs are.
An economist can also function as a speculator in her own capacity. George Soros making predictions about the denouement of the current crisis is based on his own self confessed speculative activities.
One problem with Dr. Roubini is that he does not belong fully in any of the above three categories. The more serious problem with him is that he makes wild predictions and prognostications, with or without any sound economic reasoning behind them;much like a sensational reporter; many of the predictions he puts forth are extremely dubious and unlikely.
People are very much agog in watching these fear mongers right now, believing that the fear mongers are somehow better than the ‘Evil Wall Street Banksters’, et al. There will be no point in realizing with hindsight that even as the Treasury was doing its best to restore confidence in the financial system, reckless fear mongering led to a needless collapse of the architecture.

Posted by ChidambaramNovember 20, 2008 at 4:00 am

Twofish:
I think we’re saying exactly the same thing in different words. The Chinese stand is that they will take care of their local economy.
But they have $2 trillion in their forex reserve and other countries like Pakistan, Thailand, etc would like to get some help from them.
Similarly the US would also benefit from any rescue help from China.
The Chinese stand on this is that if they are to be motivated to lend out money externally either they have to get something useful to their interest on a bilateral basis. Or if Brown wants them to participate in a global rescue effort they should get a good stake and say in the IMF accordingly.

Posted by locococoNovember 20, 2008 at 4:42 am

gs, geee

lots of other posts here are much better starting points than this one, copy and paste

and while I m at it _
where s poin t 0,5 – “quantitative easing”?

Posted by NeoMalthusNovember 20, 2008 at 5:16 am

“I worry a bit that the US will do too much of the heavy lifting to support global demand and emerging economies with large surpluses will do too little, helping to sustain a larger external deficit than I would like.”

I also worry that a collapse in the USD is in the pipeline.

Posted by dfNovember 20, 2008 at 5:37 am

things are just so normal …

Posted by dfNovember 20, 2008 at 5:39 am

The fed and other central banks are doing now what they should have done back in 2002 :
Print money and forbid private agents to lend that money.
THe only way out is public money emission supporting demand and erasing foolish debts.
THis must come along a reregulation of money emission power.

Posted by ChidambaramNovember 20, 2008 at 5:51 am

b) Aggressive GSE lending. Goldman observes that the GSEs have cut back on their lending (really lending that they support through their purchases of mortgages) since the September “Agency” crisis — something that feeds into further falls in home prices. Agency spreads remain wide.

We have to understand what we’re talking about with our Simple Example Approach, which will make things really clear:
The actual mechanics of how these things work is obviously much more complicated, but as long as the logic of the example is correct its conclusions will hold after you get real world facts into it.

Suppose a private bank had earlier lent out $300,000 for a home loan in Florida in sunnier times. The home would now be worth around $240,000 in the market. The private bank gets a GSE to buy its loan and the GSE in turns issues its own bond. The GSE bond would have been worth $300,000 in those sunny times.
With the 17% fall in Florida median home prices, the market has to ask itself what the GSE bond is now worth.
GSE presumably expands as Government Sponsored Enterprise in Mandarin as well. In Mandarin, Government Sponsored Enterprise invokes a good deal of respect and faith among all regulators, investors, etc.
Enter the Treasury’s Conservator Ship. It’s not clear how conservator ship translates in Mandarin. All the regulators, investors etc might have had to hold a big Committee Meeting to understand what exactly Captain Paulson is announcing.
Similarly nothing gets decided or acted upon in Japan unless there is a really large group discussion about it. Secondly Japan is in a permanent state of consensus gathering. Even if one member of the Board of Governors on the Bank of Japan nods the other way, they will decree lack of consensus and re start the group discussion all over again.
With all the Committee Meetings and Group Discussions, poring over all the complicated agreements between GSEs and their regulators, what they would have finally classified the GSEs as is ‘Private Companies’.
I’m 100% sure about it. I don’t think any Government Sponsored Enterprise in the People’s Republic would need to have these kinds of contractual ambiguities in their charter.
Once everybody agrees that the GSEs should be thought of as ‘Private’ the value of our bond above falls down to $240,000 from $300,000.
Also it implies that after all these Committee meetings, if the regulators continue to hold on to the Agency bonds, then they will be assuming the responsibility for any potential Agency defaults.
So they will off load all the Agencies and buy Treasuries to replace them.

Chidam: Suppose a private bank had earlier lent out $300,000 for a home loan in Florida in sunnier times. The home would now be worth around $240,000 in the market. The private bank gets a GSE to buy its loan and the GSE in turns issues its own bond. The GSE bond would have been worth $300,000 in those sunny times.

There wouldn’t be any loss for agency bonds, since GSE only issues bonds for 80% of the value of the house and only to people with good credit who would likely pay even if the house was underwater. The reason agency bonds have taken a hit is that people had thought six months ago that they were as good as US Treasuries, when today they are “merely” as good as high grade corporate bonds.

The thing that would cause GSE’s to tank would be if you have massive job losses. People with good credit will pay their mortgages as long as they are able, but if someone loses their job, then they just can’t pay.

Chidam: With the 17% fall in Florida median home prices, the market has to ask itself what the GSE bond is now worth.

Pretty much what was was six months ago. The financial structure of home loans is such that the homeowner is the person that is supposed to absorb the loss if the home prices go down. In conforming mortgages, the homeowner has to put up 20% of the initial cost of the house, and once you go for a few years, the amount of equity that the homeowner has should increase. The reason people call this “equity” is the same reason that people call stocks “equity”. If you own 60% of your house, and prices go down 20%, it really doesn’t matter.

The problem is that you had all sorts of products that tried to turn equity into cash, and this made the system very unstable to a price shock.

GSE’s got into trouble when they started doing subprimes. If they had stuck to what they were originally intended to do, they wouldn’t have gotten into trouble. The problem is that when they were structured as for-profit companies, it’s hard not to chase profits when everyone else is doing it.

Capitalism will again be the big loser during this depression, all because economists failed to understand that an international system that permitted growing mercantilism was not sustainable.

The developing countries were getting more and more income from exports while restricting their spending on imports, forcing the United States to borrow more and more to pay for imports. Eventually, the mercantilist countries bankrupted enough consumers and banks in the non-mercantilist countries to send the world’s economy into a tailspin.

The solution to the current depression is balanced trade. The United States could immediately come out of the depression by imposing balance on its trade through Waren Buffett’s import certificates.

This is *hardly* the worst financial crisis since the Depression. The Asian financial crisis was much worse than this. Same with the Peso-crisis of the 1980’s and the lost generation in Latin America. That’s not even getting into the Great Leap Forward, the Cultural Revolution, or the collapse of the Soviet Union.

It *feels* bad because this is the first major financial crisis that the United States has had in about a generation, and when it’s *your* house that is on fire, people react differently. But people really need to take some deep breaths, and not totally panic. The problem with panicking is that when people panic they stop thinking, and stop thinking is not a good thing to do in these situations. A lot of the panic comes from fear of the unknown. It’s not so much that the market drops 500 points, it’s *OH MY GOD, WHAT’S GOING TO HAPPEN TOMORROW*.

Posted by praxis22November 20, 2008 at 8:50 am

Dr Roubini is not a scaremonger, he’s been scarily accurate so far. In fact it’s only thanks to him, Brad, and a few other financial journalists that understand the credit markets, that we’re as informed as we are.

You need to understand what it is your being told, I can think of no better way of doing this than to click on a video link at ft.com and then type:

bartiromo

into the red search box, bottom right. This should return 3 videos of Mrs B being interviewed by Gillian Tett. Associate editor of the FT and somebody who’s both formidably bright & understands the credit markets.

calmo: The unemployment stats are not as accurate as one might wish, but in my view it does not take many unemployed young men to create a serious social problem.

But unemployment is not a terribly difficult problem to solve. The worst case scenario would be a massive public works program. If you can’t find the money, borrow it. If no one is willing to lend it to you, print it.

Part of the dynamics is that policy is pretty much frozen until 1/20/2009. There are standard ways of getting out of a recession/depression, but we can’t do any of them until the new administration goes into office. Right now, Obama can’t propose anything because anything that gets proposed right now will get torn to shreds before there is any chance of actually implementing the idea.

Posted by ChidambaramNovember 20, 2008 at 8:58 am

Twofish:
The reason agency bonds have taken a hit is that people had thought six months ago that they were as good as US Treasuries, when today they are “merely” as good as high grade corporate bonds.

Exactly, Twofish !!!
Rem Acu Tetigisti!!!

This is exactly what I’m saying.

Unless Treasury gives up making complicated announcements from the soapboxes with ships, sails, tacks and all … and makes out a straightforward full faith of the united states guarantee, the Agency demand, especially foreign demand for Agencies will not pick up.

Every other guarantee was fully Treasury backed, but not this one … for obvious political reasons. The Agencies are too much of a Democratic vote buying machine for Captain Paulson’s soapbox speech writers.

The FDIC guarantee for bank deposits, guarantees of money market funds; every other guarantee was full faith.

Solving the current crisis requires this bug to be fixed.

Building a new global architecture; Americans giving up cigarettes, exercising more and setting up bigger Boeing plants; constructing nuclear fusion plants; inflating all the car tires regularly; driving around the interstate highways at 20 miles an hour in electric cars; spending tons of tax payer money to build new bridges; etc … all of these are long term issues and should not be confused with ‘what lies clearly at hand’.

If the Treasury were to make it clear that the Agencies are what everybody earlier thought they were … US Govt backed organizations that can’t default … it would create a big rush for people to buy up the Agency bonds; in turn this improves the valuation of US homes; and it can potentially lead to a recovery.

Though OFHEO data clearly shows signs of a marked recovery in the mortgage market, I feel more discouraged every time I read about the layoff numbers in the newspapers … Citi alone plans to sack 53,000 people and get itself a nice little afternoon nap after many years as the credit crisis thaws out.

Also emerging markets are extremely small and for the purposes of dealing with any problems in the US economy, they are mostly irrelevant. The Fed has dumped $130 billion in AIG and pledged $700 billion. That makes the $200 billion trade deficit with China, irrelevant in the grand scheme of things.

People like to focus on other countries, because it is politically convenient to bash people that can’t vote, but if you look at numbers, what China does is basically irrelevant compared to what the United States does. Much of the reason that China isn’t trying to “save the world” is that people in Beijing can add, and they know that they can’t.

Posted by bena gyerekNovember 20, 2008 at 9:05 am

three step process:

1. maintain confidence in the dollar and the treasury market. lend $2-3tn to the banks secured on worthless assets, which they can hoard in short-term treasuries. spend $700bn+ on recapitalisations – in effect the taxpayer underwriting the first $700bn losses in the insolvent financial system. don’t waste your bullets on the real economy. hush up any suggestion that citibank (or any other financial institution of lehman-like proportions) is actually already completely insolvent if it reported its financials honestly at mtm. talk up the risks of deflation and keep medium-term interest rate expectations at zero. do not criticise china or other asian exporters – keep them accumulating us treasuries.

2. borrow a humungous amount of money. do it by issuing lots of dollar-denominated treasuries to said asian exporters. spend the money on infrastructure and other productivity-boosting spending. use some of it to help the poor with tax cuts / effective debt foregiveness, but do not otherwise try to stimulate consumption, which is falling from overbloated levels anyway. raise the money quickly, but spend it slowly and sensibly.

3. engineer a total capitulation of the dollar. attack china and other asians for subsidising their exporters directly and through reserve accumulations. blame them for killing us manufacturing. blame them for extenuating deflation in the us economy. threaten retaliatory measures to limit us imports. start aggressively monetising us government debt in the name of combatting the deflation. talk up the medium-term prospects for a return to inflation. one or more of the asian countries will flake, precipitating an avalanche that will bring down the whole dollar/treasury ponzi scheme.

sequencing is everything.

Posted by bena gyerekNovember 20, 2008 at 9:11 am

chidambaram,

if the federal government explicitly guaranteed agencies, it would double its liabilities overnight. the market would choke and the dollar could collapse prematurely (see my previous post). certainly something worth doing after the fiscal stimulus has been financed, but not before.

Chidam: Unless Treasury gives up making complicated announcements from the soapboxes with ships, sails, tacks and all … and makes out a straightforward full faith of the united states guarantee, the Agency demand, especially foreign demand for Agencies will not pick up.

Treasury can’t. Only Congress can borrow in the name of the United States, and figuring out what to do with the GSE’s is going to take six months to a year. If the US really wants to jump start the housing market, it’s going to have to issue Treasuries and then have the US Government buy GSE bonds. Whether this is a good idea or not, I don’t know, but I’d be very nervous about doing this, since it doesn’t seem to me to be the most effective way of using money, and I’m also not sure that spending six months to a year arguing about what to do with Freddie and Fannie is the most effective use of Congressional time.

Chidam: Every other guarantee was fully Treasury backed, but not this one … for obvious political reasons. The Agencies are too much of a Democratic vote buying machine for Captain Paulson’s soapbox speech writers.

One ground rule. If we want to fix the problem, then past is past, and people have to agree not to try to turn things into an issue to beat the other party up with. If the story of Freddie and Fannie turns into, it’s Party X’s fault, then you aren’t going to get anything useful done. If you want to turn something into an issue for the next election, that’s fine, but then nothing is going to happen.

One rule I have is that any time someone turns something into a simple story in which someone else was at fault, there are missing parts in it.

Chidam: The FDIC guarantee for bank deposits, guarantees of money market funds; every other guarantee was full faith.

FDIC is full faith and credit. Money market guarantees funds are *NOT* full faith and credit guarantees. It was a temporary measure to restore confidence in the market, but the government can (and in fact will) withdraw those guarantees.

Chidam: Solving the current crisis requires this bug to be fixed.

I get very impatient with people who say to fix the problem, you must do *X*, because sometimes it turns out that you just can’t do *X*. It may be that you just *can’t* get Congress to go along with extending full faith and credit guarantees to GSE’s. In that case, what do you do? It may be that there is *no way* of reviving the housing market. If your pet plan doesn’t work, then what? Give up?

Also, “solving the crisis” is a bad way of thinking about it. It’s better to think in terms of “managing the crisis.”

Chidam: it would create a big rush for people to buy up the Agency bonds; in turn this improves the valuation of US homes; and it can potentially lead to a recovery.

I don’t think this is a good thing. US home prices were too high and probably are too high and needed (and still needs) to drop. There are a number of ways of seeing if prices are reasonable. One is to compare prices with historical averages. The other is to look at rent returns and see if they are reasonable.

I just don’t think that pumping money into houses is the best long term way of arranging stimulus.

Posted by ChidambaramNovember 20, 2008 at 9:22 am

Bena:
From your previous post you seem to be an extraordinarily smart cookie. But I bet you’re new to off balance sheet accounting tricks.
e.g. when you make out a guarantee, the whole amount you guaranteed doesn’t port on to your full balance sheet. The guarantee is just a ‘contingent liability’ and you can estimate and provide for it on your actual balance sheet.
Besides you have to acknowledge that the dollar note is just another treasury note which is defined as legal tender. Credit risk on Treasury notes is zero because the treasury note is defined that way.

To bena gyerek: I’m missing the ultimate purpose of that three step plan.

Posted by ChidambaramNovember 20, 2008 at 9:35 am

my problem is with step 4 .., as I asked you in my previous post … how would anybody like to pay $20 for an all american nail clipper instead of $2 for a made in china one?
how would anyone like to pay $150 for a creaseless shirt instead of $40 for one from Bangladesh?
how would you like to pay $150,000 per annum for every programmer instead of $30 per hour for some unseen chap in hyderabad who can’t spell helicopter gunship ?

Posted by bsetserNovember 20, 2008 at 9:38 am

Chidam — the freddie/ fannie bailout was structured the way it was in part to avoid consolidating the GSEs on the US government’s balance sheet with an associated increase in the public debt. What matters here is less balance sheet accounting tricks than the rules governing the public sector balance sheet/ balance sheet consolidation.

2fish — China doesn’t have the capacity to backstop both the us financial system and china’s financial system, that’s true. but i suspect you are understating china’s importance; right now china has a $400b bop surplus, which makes it by far the largest creditor country in the world. the collapse of commodity prices has strengthened its role here. and relative to the reserves of most emerging markets, the incremental annual growth in China’s reserves is quite large. China has opted not to strike out on its own as a global dollar lender of last resort — but will and capacity are different. China certainly has the capacity to be an alterntive to the IMF (or to the fed’s swap lines) for most emerging economies. To date though it hasn’t wanted that role.

finally, while asia’s crisis/ the peso crisis may have been worse for the countries involved, it wasn’t worse for the US — and this was a post about the US. and given that this has been a synchronized global fall, i suspect you can argue that on a global scale, it is one of the worst crises in a very long time.

back to the questions of the post — what should the US government do now to contain the economic downturn?

Posted by ChidambaramNovember 20, 2008 at 10:18 am

Brad:
One specific thought is to utilize the recent strengthening of diplomatic ties between India and united states to increase specific exports to India.
Again this is in the form of something which I think is ‘clearly at hand’ though the devil might be in details unknown to me.
On one of his past visits to India Jeff Immelt, the CEO of GE mooted a proposal to various political leaders in India to set up private nuclear power plants in India. The policy makers agreed.
But the problem was that the ruling government in India is a coalition government with some Left parties supporting it.
While India has its won nuclear program both both defense and civilian purposes, this program was largely based in indigenous technology since the related technology transfer is severely restricted.
But after protracted diplomatic negotiations over stuffed quail with countires around the world, there has been international ratification of civilian nuclear technology transfer to India.
Currently there are discussions on with nuclear power companies in the us, Canada, etc to set up nuclear power plants in India.
In terms of demand-supply electricity in India is a severe case of a long term supply side problem. Currently the large cities in south India are subject to 4 hours of power cuts every day. What I gather is that the government is explaining that there has been a 50% drop in power generation at their Kaiga nuclear power plant due to Uranium shortages. At the same time the hydroelectric power generation facilities are also malfunctioning for some fancy reason or other, other than lazy bureaucrats.
This move can increase sales from an American nuclear power company either by way of a sale to the government of India; or it could simply be a private nuclear power plant generating revenues for the firm in a general situation of declining global demand.
I did look up McCain plan to set up 40 nuclear power plants in the united states. Typically it takes at least 5 years to build a plant in the united states under current regulations but easing regulatory roadblocks can reduce this to 3 years at most. One issue with it is that I don’t think there’s an active shortage of power supply in the united states so it might very well be another case of trying to create demand where it doesn’t exist.

Posted by DJCNovember 20, 2008 at 10:23 am

The global banker is called the USA and the currency in question is of course the US dollar. The US was fundamentally able to resort to this scenario due to the Organization of the Petroleum Exporting Countries (OPEC) agreeing (in 1971) to trade oil in US dollars. By now, having the sale of crude oil barrels, relatively costly and traded in their millions per day, in dollars, the US currency was now an essential requirement to facilitate trading on an international level. Not only was crude oil now traded in dollars, but other major commodities also followed suit, including gold.

Almost 40 years on, due to a mixture of reckless lending practices, fundamentally flawed trading processes of the likes of short selling, credit default swaps, derivatives trading and so on, the Western banking system has been placed on the verge of collapse due to the gigantic losses the banks have incurred.

Despite dictating their capitalistic philosophy globally (forcing Third World countries to liberalize their markets by removing trade barriers, allowing the privatization of state assets at heavily reduced prices), when their turn has finally come, the Western governments are hypocritically demonstrating that they are not prepared to let their financial institutions collapse by being subjected to the much-advocated force of the free market.

Apart from the plugging of a few holes via various investment means (including getting funds from Gulf nations), the Western banks have been essentially left with no option other than to go with begging bowl in hand to their respective governments and plead for bail-out packages. The governments in turn, having close ties with the elite of the financial world and to avoid a run on the banks and total economic pandemonium engulfing their societies, have in turn been left with no option other than to plough billions of dollars into the banks.

Make no mistake – this is theft, and a theft on a colossal and universal scale. And it is a theft of a unique nature, not being possible beyond the workings of this model.

There is no need to take possession of the physical sums of money individuals in the society may possess. But rather, whether people’s hard-earned funds are placed in vaults or under mattresses, the value or purchasing power of these savings is gradually being siphoned away by those who are the recipients of the newly generated funds, which is to say the banks. The more dollars that are printed and placed into circulation, the more the value of existing dollars (and currencies which are pegged to the dollar, such as the Saudi riyal) are being stolen.

Brad:
What would you think of American Dream Act II ?
The current problem is that banks are requiring at least a 10% down payment and high FICO scores etc to lend out on homes. Similarly demand to buy new homes is not great. While this problem does exist, it should NOT imply lack of demand for Everything.
Consider for example College Education For All soaps delivered by the President Elect from various soapboxes all around the country.
College Education is something that many people would like to have but can’t afford. Lend out huge sums of money irrespective of FICO scores for both full time and part time college education Repayment doesn’t start till the course is completed.
The current levels of unemployment must be reminding everybody about Education and I’m sure lots of people will actively borrow to go for some college courses.
Borrowing for college courses is not something that can easily be termed as “American Profligacy”.
Once the securitization machine gets re started, you buy some time to do some meaningful things like increased exports, re balancing global exchange rates, etc

Posted by RBGNovember 20, 2008 at 11:01 am

Thank you, Brad,

and just one follow up question –

i think gov injects cash to banks firstly because banks are insolvent, but secondly because that insolvency is limiting (reducing) banks lending capacity.

so, are tax payers better off if the banks buy treasury with the additional cash instead of lending them?
U.S. might not have to try to sell much debt overseas and not lose more negotiation power against China, but given the tight money condition for many citizens and companies, i don’t think it is how the injected capital should be used.

Would appreciate your opinion. Thanks.

Posted by ChidambaramNovember 20, 2008 at 11:25 am

DJC:
The current crisis is in fact showing up the robust nature of the free market rather than the other way round.
The market value of a bond is determined by its principal, interest rate and credit risk. The market in toto has consistently ignored the probability of default both during the boom and during the current downturn in home prices.
Similarly the ‘losses’ of banks are not as great as you picture them to be. I’ve been consistently maintaining that outstanding CDS principal totals should be counted as ‘losses’ and data from your post about the Lehman settlement shows this to be correct. For the most part a loss for somebody in a CDS contract also means a gain for somebody else in a CDS contract. The net settlement in the CDS contracts has to tally with actual loss from reduced recovery on loans.
However there is a ‘Big Bug’ in the global macroeconomic system and we’re trying to see if there is a way to fix that bug. If there’s no way to fix that bug, then the solution is to re direct the system on the same principles but in such a way that this particular bug is eliminated.
The Big Bug I’m talking about is the legal status of the Agencies. The market earlier thought that the Agencies can’t default, but this is now ambiguous. Foreign demand for Agency bonds has fallen off as a result. The sudden fall in demand for securitized instruments issued from US institutions created a dire need for regulators to take urgent actions to provide much needed liquidity to the financial system.

The Treasury and the Fed have been extending new credit to private banks, buy equity stakes in some of them, and providing full faith and credit guarantees in some cases. These actions do increase the money supply as you indicate in your post. At the same time so far there is no evidence of any actual losses for taxpayers from these actions, though there is exposure to credit risk from defaulting taxpayers.

Posted by ChidambaramNovember 20, 2008 at 11:34 am

Correction: I forgot to put a NOT in this sentence. CDS outstanding is NOT equal to losses.
I’ve been consistently maintaining that outstanding CDS principal totals should be counted as ‘losses’ and data from your post about the Lehman settlement shows this to be correct.

Posted by PatrickNovember 20, 2008 at 11:51 am

The US gov’t has to be very careful to direct stimulus spending to productivity enhancing capital/infrastructure.

The energy problem is only on hiatus, so that would be a good place to start. Rail is much more efficient than cars, and the US rail system is a mess. Moving goods by water is the most efficient means of transport in energy terms, but the canals and waterways have all been turned into condo developments and parks. They need to be reactivated for commerce. Our fossil fuel infrastructure is rusting and needs to be refurbished (fossil fuels will be with us for a long time to come).

What I would not spend much money on are more roads, bailouts for anything related to the automobile industry, or the airlines. They’re going to die and there is nothing that can save them. Let’s not through good money (what little there is of it) after bad.

Posted by bena gyerekNovember 20, 2008 at 11:54 am

the usa needs to make two major structural changes to its economy, sooner the better:
(i) investment in real estate needs to be replaced by investment in infrastructure;
(ii) overbloated consumption needs to be replaced with a current account surplus.

the nature of the current bubble in the dollar/treasury market makes sequencing very important.

firstly, the federal government should borrow as much money as quickly as possible while china and others are still happy to invest in the dollar/treasury bubble, which is making federal borrowing costs irrationally cheap. this money should be spent on (i) above.

then the government should do everything it can to devalue the dollar. devaluation is the best response to the economic downturn. it will achieve (ii) above. it would also go a long way to mitigating deflationary pressures.

however, devaluation will also pop the treasury bubble. which is why sequencing is important.

i wonder how long it will take china and the others to realise that they are “it”.

Posted by ChidambaramNovember 20, 2008 at 12:23 pm

Twofish:
If you think there’s no way to short sell a house then you’re new to the ‘cash back at closing’ trick. A good portion of mortgage loan losses for banks in Florida and California was due to ‘cash back at closing’ deals promoted by ‘foreclosure investors’ who were basically running a sweet scam.
The scheme works like this:
There’s a house which is either already foreclosed or it’s close to foreclosure. The bank and the existing owner are both desperate to get rid of it. So you go there through your ‘foreclosure investing’ sponsor scam firm and negotiate a pretty reasonable price to buy it. Your deal with the bank is a ‘cash back at closing’ transaction where you don’t actually buy the house; you just have a sales agreement to buy it at the negotiated price. Then the scam firm will bring a dummy borrower into the picture who will then buy the home from you at a much higher price. So now the bank has to pay you the difference between what you negotiated on the buy and sell of your transaction. The dummy borrower will simply default on their loan and disappear. As long as banks were willing to accept Matricula Consular ID cards from borrowers, accept low FICO scores, or no FICO scores, with no verification of either income or identity beyond the MC, it was possible for the scam to produce infinite numbers of such dummy borrowers and defraud the banks. It’s also possible that in some cases the bank managers themselves were party to the scam, but cash back at closing is perfectly legal and you can’t prosecute anybody in the US unless they’ve actually broken an explicit law.

Posted by ChidambaramNovember 20, 2008 at 12:55 pm

I have two useful points to add .. sorry I took my eye off the ball with that cash back at closing distraction.

1) I agree with Bena’s idea that infrastructure is the way to go. The possibility of a build-own-transfer model for private firms to invest in infrastructure should be fully explored, along with other such models.
The reason private investment in infrastructure helps is that when the government spends directly on new infrastructure what you get is a Keynesian Placebo which creates a corresponding increase in the money supply and increased inflation.
Witness this quip from the late Lord John Maynard Keynes:
“When the facts change I change my opinion. What do you do sir?”
To be classified by me as a dinosaur you don’t have to qualify through a high biological age. You could be just 22 and get classified by me as a dinosaur. Also the age in which somebody lived doesn’t qualify them to be a dinosaur.
Keynes in his time was definitely not a dinosaur. Similarly I can never classify Greenspan as a dinosaur despite his being older in biological terms.
What we need to do is invent new placebos, adopting the Keynesian style.

2) My second point is related to the first one and it’s a second thought on the rules governing the consolidation of public sector balance sheets. As of their latest reporting the Agencies are by and large solvent entities. If there’s a rule that their liability should add on to the liability side of the Govt.’s, then correspondingly their asset side should also add up. So providing a full faith and credit of the united states guarantee should add the net worth of the agencies to the public debt and not the total of their liabilities. Their net worth could even turn negative in future, or found to be negative at present on closer scrutiny; but given the total size of the bailouts so far the beneficiary effects of this guarantee will far outweigh its negatives.
Getting new funding from China and other foreigners for Agency bonds without further issuance of Treasuries will stop further increases in money supply for bailouts. At the same time I would like to correct it if I’ve created a perception that the Agency Bug caused the crisis. The Agency bug is some collateral damage from the crisis which we have to deal with but it was not the bug which caused the crisis.

Chidam: If you think there’s no way to short sell a house then you’re new to the ‘cash back at closing’ trick.

That’s not short selling a house. If the price of the house goes to zero, you don’t get the original purchase price.

Posted by ChidambaramNovember 20, 2008 at 1:46 pm

Twofish, once again sorry about the distraction with cash back at closing. Our objective here is to idetify actions/suggestions that are ‘clearly at hand’ which can help resolve the economic woes of the US economy.
Other than the orientation to act constructively and aggressively the only asset Americans have that can’t be dismissed as ‘burst bubble’ is our wonderful sense of humor … so let’s also try to have some fun solving this credit puzzle!
And don’t try to convince me, ever, that ‘there is no solution’. Every problem comes with an attached solution; it’s up to you to find the solution. Both the problem and the solution are simply products of the human mind and neither of them is ‘out there, somewhere’ as the fear mongers like Dr. Houdini aggressively project.

Chidam: The Big Bug I’m talking about is the legal status of the Agencies. The market earlier thought that the Agencies can’t default, but this is now ambiguous.

The market thought that if the agencies were likely to default that the government would have picked up the tab, and they were right. Also there is agencies pass through debt and agencies corporate debt which are very different.

I see no reason why agency corporate debt should ever have had any government backing at all.

It’s actually not ambigious at all. The government has promised $150 billion to backstop the GSE’s. If that gets burned through then people should not expect any more money from the government.

Chidam: Foreign demand for Agency bonds has fallen off as a result. The sudden fall in demand for securitized instruments issued from US institutions created a dire need for regulators to take urgent actions to provide much needed liquidity to the financial system.

No. This isn’t true. There was a liquidity crunch in September, but there isn’t one now in mortgage backed securities. Foreign investors have stopped buying new ones, but they aren’t dumping old bonds.

Chidam: The Treasury and the Fed have been extending new credit to private banks, buy equity stakes in some of them, and providing full faith and credit guarantees in some cases.

Treasury and the Fed cannot provide full faith and credit guarantees. Only Congress can. The only new full faith and credit guarantees are extension of FDIC and added Treasury lending.

Personally, I think it is a very bad idea to extend full faith and credit guarantees to Freddie and Fannie. If the government wants to recapitalize things, it can buy bonds itself.

2) Have the government pass a GI Bill like bill that gives former autoworkers free tuition at the college of their choice. One possibility is that they can go to nursing school to get the money that the government is now spending on health care.

3) Ask the UAW how much money that want in a lump sum to get buy any contract provisions that prevent GM from restructuring. Have the government pay the money and get back GM stock.

4) Fire the management of GM.

5) Repeat as necessary for any other large or small corporations that are in trouble.

Posted by ChidambaramNovember 20, 2008 at 2:05 pm

Patrick:

What I would not spend much money on are more roads, bailouts for anything related to the automobile industry, or the airlines. They’re going to die and there is nothing that can save them. Let’s not through good money (what little there is of it) after bad.

Patrick, I think we should not miss the interconnections among various sectors of the economy and also the interconnections among different national economies. What’s required is to ‘find the bug’ which caused this crisis. The situation is one where something has failed at one point and this has caused ripple effects financial light years away from the course.

To analyze this in a systematic manner we have to first establish the first failure. Then we have to look at the proximate causes of that failure and remedy the situation.

The policy challenge is that since various different institutions are closely linked, failures are getting transmitted. So it will not be easy to keep propping up various organizations in various sectors turn by turn. The root cause has to be found and eliminated.

One constraint is that global capital flows are circular and reflexive in nature. I’m still reasoning out o the reflexivity aspects of this crisis.

George Soros may have successfully broken the back of the Bank of England but this need not necessarily mean that he and his pal Jim Rogers will succeed where the Fed and Treasury are concerned.

Posted by donNovember 20, 2008 at 2:07 pm

Tyavresun, KnotRP, NeoMalthus – you are right on.
Zanon – The question is not the share of imports in U.S. GDP, the question is how much of the bailout money is provided by borrowing from foreign lenders. The net increase in foreign borrowing is equal to the net decline in the current account balance, so that is the share of the bailout that goes to support demand in foreign countries.

Posted by ChidambaramNovember 20, 2008 at 2:55 pm

Thinking about George Soros and Jim Rogers has me seriously worried about a more immediate and much more proximate collapse than any of us could have imagined or reasoned till now.
The only thing I’m willing to concede to Dr. Roubini is that each and every one of his dire predictions will come true exactly as he says if the US dollar either collapses, or even if it undergoes a relatively short term adjustment against major world currencies.
A collapse in the us dollar will leave us in a completely different world where we cannot continue our analysis to identify and fix the bugs in the existing global financial system, or even any medium term re design of the global financial architecture. It will be a different world with different paradigms requiring new modes of reasoning than the ones we have now.
The effect of a collapsing dollar on the domestic us economy will be to shoot up retail prices overnight. The effect of hyperinflation on home prices is downwards rather than upwards. The housing market can easily tank 40%, as Dr. Roubini prognosticates, if there’s a 40% drop in the value of the us dollar against a basket of major global currencies. Hyperinflation will trigger higher interest rates, which will further inhibit economic activity and lead to even lower demand and even higher unemployment.
Check
It’s difficult for me to know if a challenge to the supremacy of the us dollar from China, with the us on the brink on the above effects, can be settled without a war.
Checkmate

Chidam: Thinking about George Soros and Jim Rogers has me seriously worried about a more immediate and much more proximate collapse than any of us could have imagined or reasoned till now.

Jim Rogers is totally clueless. George Soros knows a few things, but what he thinks isn’t that relevant.

What the past two months has shown and what the past ten years has shown is that in a crisis, the dollar strengthens. This is even if the crisis was self-inflicted. There is nothing that I can see in the next six months that will change this basic dynamic.

To talk about a dollar collapse, you need to talk about what to move the dollar to. There aren’t enough commodities in the world, and anything else will die faster than the dollar if something bad happens.

Chidam: The effect of hyperinflation on home prices is downwards rather than upwards.

Inflation is not something that one can reasonably worry about in the next year. Right now fear of inflation is more dangerous than inflation since it leads to bad policy choices.

Now is the time to print money.

Chidam: It’s difficult for me to know if a challenge to the supremacy of the us dollar from China, with the us on the brink on the above effects, can be settled without a war.

China has neither the will, interest, or ability to challenge the United States for global power. China has no more interest in global power or in challenging the United States than France or Argentina do.

Posted by lbNovember 20, 2008 at 3:52 pm

moldbug: “Therefore, I suggest a more drastic cure for deflation which is also likely to be more popular. Simply rebate all taxes due for the year 2008.”
i actaully think this is so elegantly simple that it’s worth discussing further.

knotRP: “A tax rebate would be blown on imports, which just prolongs (and enlarges) the problem.”
that’s an assumption, some would say an incorrect one given the data of last years’ rebate and where it went.

if there was any year this could work it would be this one. remember that tax revenue is going to be way down anyhow, due to a decrease in income & capital gains losses.
(although i would propose that taxes on capital gains should NOT be subject to a rebate, if for no other reason than to make it more politically viable.)

i say bring on the arguments why this would any worse than any other solution floating out there…but to ignore it because it’s too simplistic is missing the point: its effectiveness on multiple levels (politically, economically, socially & morally) is exactly BECAUSE it is so simple.

Patrick: What I would not spend much money on are more roads, bailouts for anything related to the automobile industry, or the airlines. They’re going to die and there is nothing that can save them.

If they are going to die, then we need to spend a lot of money to bury them. Shutting down a company or an industry is extremely disruptive and expensive, and if the auto industry has no future, then perhaps the best thing to do is to spend money to wind it down.

Go to all of the auto workers, and give them a lump sum of cash to thank them for their years of service and to move them on to the next industry. China did basically that in the 1990’s when it smashed the iron rice bowl.

This is something that people I think didn’t get about the financial “bailout.” Most of the money didn’t go to keep the system running as is. Most of it went to shut things down. It was less a bailout than a post-disaster clean up.

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“back to the questions of the post — what should the US government do now to contain the economic downturn?”

Bear with me for a long suggestion.

People from all over the world send goods to the U.S. because they are confident that the contract promising to pay for the goods will be fulfilled. Britain’s ascent to the strongest economy in the world in the early 1800’s was greatly aided by the fact that the British courts could be counted on to enforce contracts. Confidence that contracts will be fulfilled is the foundation of the modern, impersonal economy.

But what if one of the parties to a contract is not able to pay? The answer to inability to pay: foreclosure and bankruptcy. Foreclosure and bankruptcy are enforced by courts.

But these court enforced solutions to lack of ability to pay depend upon normal times when most contracts continue to be paid. Under those conditions, foreclosure and bankruptcy enable the debt holder to recover a sizeable portion of the investment. Normal times also means that most contracts are fulfilled because most debtors can pay. In normal times, when foreclosures and bankruptcy are rare and limited to small firms on the fringe of the economy, those events do not cause widespread fear that existing contracts will not be fulfilled.

The failure of Lehman Brothers and AIG sent shock waves through the financial system because these firms were large (AIG was the largest insurance firm in the world) and they were involved in a great many contracts with other financial firms. The shock was compounded because the regulator and rating agencies did not have information about the contracts which caused their failure (the law removing these contracts from public view was passed in 1999). Enough people knew about their problems to drive the value of their stock down to near zero.

These are not normal times. No one knows the total extent of toxic assets carried on the books of U.S. financial firms – or precisely which firms are sound and which are not. In the absence of information, the rational response of banks is not to trust other banks.

Bernanke and Paulson do not really understand the type of abnormal situation existing today. The fear among banks that they want to dispel is not based on a mistaken reading of reality. It is rational, given the nosedive of the economy and lack of information about the soundness of counterparties. This fear will not be overcome by infusion of more money on to the balance sheet of banks.

Governments have no good examples of the proper governmental response to abnormal times when the fear that contracts will not be fulfilled is rational (rational defined as based on real events).

Thinking outside the box would begin with the assumption that either: a) Not all the existing toxic contracts can be paid for by private entities, or b) Not all the existing contracts SHOULD be enforced in U.S. courts because to do so might wreck the existing financial system, or c) Some contracts should not be enforced in U.S. courts because they are illegitimate contracts – created without proper disclosure to all parties. This third option was used by the Attorney General of New York and Connecticut as the basis of a law suit settled out of court which forced some financial firms to return money to investors..

Acceptance of any of the three options move the discussion to the question of how U.S. courts should respond to the demand that contracts be enforced in the normal manner. Here are two options for consideration.

Requests for foreclosure on residential mortgages should trigger the following response: 1) The Federal government send a check for $1,000 to the court, said money to be used to pay for record keeping and to pay for a credit counseling agency to investigate whether or not the house occupant could pay his monthly mortgage obligations for the next 3 years, if the mortgage were reduced to 70% of the existing payment and THAT AMOUNT FROZEN FOR THREE YEARS. If the answer is yes, the court will accept that monthly amount from the house occupant and forward that to the investor. If the answer is no, the foreclosure will proceed. After three years from the time the request was received, the courts will be required to return to the practice of enforcing contracts in the normal manner.

The request for enforcement of a contract derived from a mortgage (such as an insurance contract to pay the amount of the mortgage in the event of default), will require that the contract be presented to the court and the court will be required to recalculate the total owed to fulfill the contract based on the current default rate rather than the default rate that was estimated at the time the contract was signed. Contracts derived from bets on non-mortgage events, such as future interest rates, will not be modified and will be enforced in the normal manner.

Ex-post factor modifications of existing contracts is clearly undesirable, in normal times. The above proposal makes sense only if the current conditions are as bad as Paulson claimed when he made his pitch to the Congress in September.

Posted by ReformerRayNovember 20, 2008 at 5:31 pm

The above posts says that the solution to our current problem is to pass a law which prohits enforcing existing contracts as written in the Courts in the U.S. without an modification of some of these contracts.

ReformerRay: People from all over the world send goods to the U.S. because they are confident that the contract promising to pay for the goods will be fulfilled.

Actually no. People send goods because there is an orderly process of determining when a contract will be paid and what happens if it can’t be. Sometimes you sign a contract with them, and it turns out that they just don’t have money.

ReformerRay: But what if one of the parties to a contract is not able to pay? The answer to inability to pay: foreclosure and bankruptcy. Foreclosure and bankruptcy are enforced by courts.

There are other things. You can seize collateral. You can stop issuing new contracts. Also people misunderstand what bankruptcy is. Bankruptcy usually isn’t what your creditors do to you. Bankruptcy is what you do to get yourself out of a contract. One of the things that makes resolving this issue more difficult is that the banks changed the laws to make it harder for individuals to declare bankruptcy.

ReformerRay: These are not normal times. No one knows the total extent of toxic assets carried on the books of U.S. financial firms – or precisely which firms are sound and which are not.

That was two months ago. I’m pretty sure that people now have a good general idea of how big the exposures are and where they exist.

ReformerRay: Governments have no good examples of the proper governmental response to abnormal times when the fear that contracts will not be fulfilled is rational (rational defined as based on real events).

Yes they do. This has happened quite often in the past.

The problem with what you are proposing is that judges don’t make the laws. They only enforce the laws as they have been written either in the constitution or in legislatures.

Now Congress does have the legal authority to change the bankruptcy code and rules on foreclosures. The trouble is that there are lots of people in Congress that don’t think that the rules should be changed, and there are enough of them to block any changes. During the TARP debate the Democrats wanted to loosen the rules on bankruptcy, but the Republicans said no.

A few years back Congress made it much harder for individuals to declare personal bankruptcy, and that has caused lots of problems in my opinion, but there aren’t the votes right now to change those laws. Things might be different next year with fewer Republicans, but you have to chose your fights carefully.

ReformerRay: The above proposal makes sense only if the current conditions are as bad as Paulson claimed when he made his pitch to the Congress in September.

Actually things are a lot better than they were in Congress. It might not seem that way. But when you first get shot, you are probably too dizzy to notice the pain. The patient is no longer in intensive care and probably not going to die, but they have a long and somewhat painful recovery ahead.

ReformerRay: The above posts says that the solution to our current problem is to pass a law which prohits enforcing existing contracts as written in the Courts in the U.S. without an modification of some of these contracts.

There is already a law like that. It’s called the Bankruptcy Code. People declare bankruptcy to keep creditors from enforcing contracts and seizing property.

You can try to change the Bankruptcy Code to make it easier for people to get out of a contract and stop foreclosure. Democrats tried that in September. Republicans said no.

Posted by ReformerRayNovember 20, 2008 at 5:52 pm

Hello. Has everbody gone to supper?

If you recoil from modifing laws related to enforcement of contracts, how about laws related to imports?

On the other hand, a 10% tariff applied to everything shipped to the U.S. that is manufactured in China, Japan, Germany, Canada and Mexico is highly desirable.

The tariff rate should increase by 5 percentage points every 6 months, to a limit of 40% (all in a law).

This will not immediately solve our finacial problem, but over time, it would gradually return the U.S. to solvency because consumption would match production.

Posted by ReformerRayNovember 20, 2008 at 5:58 pm

Good to hear from you, Twofish.

Yes, my recommedation is to modify the existing bankruptcy code.

I do not know what the Democrats proposed or what the Republican postion is. I bet the Dem. position was not the partial, measured response that I advocated. My proposal would provide more money to the investors in the mortgage, if the foreclosure process results in more than 70% decline in money received during the 3 years. Since the foreclosure process eliminates the possibility that the investor will get more of his money back after 3 years, likely my idea will increase the total return to the investor. At least, it has that possibility.

Posted by ReformerRayNovember 20, 2008 at 6:04 pm

In addition, many home occupiers will be forclosed on immediately, if their fiancial situation is terrible.

This scheme can be improved by limiting the cases to mortgages that are less than 6 years old. And by requiring the credit investigating agency to determine whether the house occupier has a good chance of meeting the requirements of the existing mortgage for 3 years. When that determination is reached, the occupant should be fined some amount, enough to discourage people with good financial prospects from ceasing from paying on their mortgage in the hopes of getting a reduction of 30%.

Posted by donNovember 20, 2008 at 6:35 pm

ReformerRay: These are not normal times. No one knows the total extent of toxic assets carried on the books of U.S. financial firms – or precisely which firms are sound and which are not.
Twofish: That was two months ago. I’m pretty sure that people now have a good general idea of how big the exposures are and where they exist.
Not unless they can accurately predict what will happen to real estate values.

> Except we are not in any sort of extraordinary problems.
> We are in the middle of a good old fashion financial panic
> which has happened every seven years or so for the last
> several hundred years.

Well, yes and no. Financial crises are as old as capitalism, but this crisis does mark a turning-point in world history: it’s the end of the bipolar/unipolar world. The BRICs aren’t going to regress to impoverished quasi-agrarian powers, they’ll bail themselves and their neighbors out and continue to industrialize. The EU will continue to expand in size and significance – they’ve already mobilized close to 3 trillion EUR to limit the crisis. I’m actually more hopeful now than I’ve been in years, because the EU and the BRICs are acting like sensible, rational world citizens, and the Obama people seem to understand and accept the reality of the situation.

But I do worry about the next sixty days. Given the irresponsibility, stupidity and suicidal self-destructiveness of the Bush oiligarchy, it wouldn’t surprise me if the last act of this gang of ghouls, torturers and war criminals was to let the US economy burn to the ground. I hope it doesn’t happen, but their track record does not inspire confidence.

Posted by ReformerRayNovember 20, 2008 at 7:11 pm

Twofish shoots down may good ideas by saying that the political system is not receptive.

He is usually right.

Receptivity changes as conditions change.

If any proposal is sound, it will be accepted, later rather than sooner, because ideas must be debated before they are accepted.

Posted by locococoNovember 20, 2008 at 7:24 pm

Brad “what should the US government do now to contain the economic downturn?”

like Pareto ment:

it could get in a car and drive itself down to the nearest prison and lock the door after.

short of that it could lock up some other guys (that it might know of).

short of that also, it can (besides that it – under their law – must) declare a Fraud as a …Fraud. There s two side ones to that one: 1) no more stupid contracts (that should bind no one in the 1st place) and 2) it could be viewed, by “the others”, as an excuse. short-short one: no more settling of (or for, whatever) this fraud.

ReformerRay: On the other hand, a 10% tariff applied to everything shipped to the U.S. that is manufactured in China, Japan, Germany, Canada and Mexico is highly desirable.

1) I don’t think it is, and

2) If we are talking about anything that will get enacted in the next year, it’s just not going to happen. If Obama makes bankruptcy reform a central part of his administration, he might be able to get the votes. However, if it tries to increase tariffs, he is just spending political capital for nothing.

ReformerRay: I do not know what the Democrats proposed or what the Republican postion is. I bet the Dem. position was not the partial, measured response that I advocated.

You can propose anything you want, and people propose lots of things in Congress all of the time. Ron Paul wants to abolish the Federal Reserve and go back to a gold standard.

The trouble is that once something gets involved in the legislative process, it changes and mutates. To get TARP passed, they had to pass an exemption from excise tax for wooden arrows designed for children and suspend duties on wool products. By contrast, the Republicans made it clear that *anything* which would allow a bankruptcy court to change the terms of a mortgage was dead on arrival.

don: Twofish: That was two months ago. I’m pretty sure that people now have a good general idea of how big the exposures are and where they exist.

don: Not unless they can accurately predict what will happen to real estate values.

You don’t need to predict. What you need to ask is if real estate goes done by *X* percent what happens? Don’t try to predict. If you think you can predict, you’ll get yourself in trouble,

In defense of Twofish, his ideas are usually more realistic than some of the others, apart from those others not always having good ideas.

What I am taking away from this discussion is the point 2fish made somewhere in this long sequence: that it will take a long time to fix the GSEs (fixing the car makers is much easier and it is a pity that this will again look like fixing the banking system: too kind for the parties responsible for the mess so it will be repeated). And that is quite plausible, since the GSE problem is there, is essential for a severe reverse wealth effect and it has many parents. I also believe that the current sell down in the equity markets is a little more structural than just unwinding of positions and pensionfunds and banks all forced by prudential rules to act -in fact- procyclically. An example of unintended consequences if I ever have sen one. But this is reinforced by what the other blogger on this site, Amity Shlaes is discussing tirelessly: aggregate uncertainty (she refers to “regime uncertainty”), slightly more specific, but either regime or aggregate, it should prompt the government (the incoming one) to waste no time in riding hobbyhorses and rewarding friends. It needs to do the things that the opposition cannot oppose, even it that means political suicide for the new gvt, such is the nature of responsible democratic government. No government has ben in a bigger trap than this one, I think. The democratic paradigm we are all familiar with is only about 60 years old and much more fragile than it looks to most of us.

Pointing to the example of Japan, Paulson said that foreign investment banks in Japan “are almost as Japanese as some of the historically Japanese institutions,” he said. “The wealth that is generated in Japan stays in Japan.”.

This is like the deer hunter, where the pow’s are forced to do russian roulette. Well, China are the vietnamese guards, and we’re de niro.

i do not have a specific remedy – because i think that to define the current situation as a ‘problem’ is illusory. we do not have a problem (which implies a solution) but a situation (which will merely have an outcome.)

printing money is not sufficient answer, it is necessary to circulate money. henry ford understood that you need to pay the automobile workers a wage that leaves them able to afford to buy your model t.

if you export model t manufacture to a low wage economy – the (e g) chinese worker cannot afford the car, while the american automobile worker is by this time unemployed and can’t afford it either.

so the modern style henry ford runs off with the profits, and the model t production line grinds to a halt, leaving both the american and chinese workers up the yangtse without a paddle.

now if bernanke’s helicopters dropped the dollar bills on the chinese workers . . .

but that is not politically possible –

so we are back to neo-protectionism.

and you can add that to the list of things above of things that seem to me deflationary.

Of course you are right – TARP spending, etc, goes straight into asset-price valuations. (Not that it is of sufficient magnitude to do much there, either.)

But $1T in tax relief and $1T in spending both result in the same thing – $1T more in checks hitting peoples’ bank accounts next year. And then presumably being spent, etc. Spending patterns will vary, of course – I buy lima beans, you buy complex structured securities, etc. But they vary for different fiscal stimuli as well.

Posted by ReformerRayNovember 20, 2008 at 10:19 pm

Will neo-protectionism lead to deflation?

No, because it will exist in an environment of expensive credit.

Restriction of imports from the 5 most effective exporters to the U.S. will tend to increase inflation but expensive credit will tend to decrease inflation. Two forces cancel each other.

Chidambaram says, “All these economists are there only to provide useful and actionable suggestions to policy makers, and to provide useful information and analysis to market participants to help with their expectations.”

Actually, Roubini has clients who pay for his advice (he’s also a teacher, but that’s irrelevant here). He has no obligation to policymakers. When he presents predictions on TV, if he’s right, he attracts more clients. If he’s wrong, he doesn’t.

Chidambaram further says, “The more serious problem with him is that he makes wild predictions and prognostications, with or without any sound economic reasoning behind them;much like a sensational reporter; many of the predictions he puts forth are extremely dubious and unlikely.”

I don’t think you’ve read his site. On it, I routinely access IMF reports, analyses by governments and financial houses, and academic writings that fully substantiate things he says. It’s an astonishing compendium of information from around the world.

Dubious and unlikely? Well, he’s been right so far. One may call being right “dubious and unlikely,” just as one may call a 20 dollar gold piece “a trout.”

___________________________

Lyle B asks why I said that The Japanese are suggesting that we should do any further borrowing with bonds denominated in yen.

2fish: “It disproportionately helps the rich.” i hate to break it you amigo, but this entire system disproportionately helps the rich. when you’re not rich, that becomes a little more clear than when you are.
“and anything requiring Congressional approval will take a year.” …you mean like TARP??? or the last rebate?
“The numbers also don’t work out.” how so??? just because you (or anyone else) say it so does not make it so.
“Except we are not in any sort of extraordinary problems. ” i think gillies answered that one already.

i really appreciate your contrarian spirit 2fish but sometimes i wonder why you continue to throw cogs into people’s ideas — is it to help them see the issue in a different way or is it to intentionally discourage anything that might upset the status quo?

lb: i really appreciate your contrarian spirit 2fish but sometimes i wonder why you continue to throw cogs into people’s ideas — is it to help them see the issue in a different way or is it to intentionally discourage anything that might upset the status quo?

It has to do with my background as a physicist. What happens is that when you come up with a new or an old idea, you have to subject it to what can best be described as an intellectual gladiatorial match, with the notion that any idea worth keeping will survive this sort of combat.

lb: i hate to break it you amigo, but this entire system disproportionately helps the rich. when you’re not rich, that becomes a little more clear than when you are.

That’s one reason the system stinks and we need to change it. I don’t see the purpose of making the system even *more* beneficial to the rich than it currently is, which is what happens if you kill taxes.

lb: “and anything requiring Congressional approval will take a year.” …you mean like TARP??? or the last rebate?

TARP is a good example. You had the Fed and Treasury and the President and the leaders of both parties all saying that it was an emergency must pass bill, and it very nearly didn’t.

lb: The numbers also don’t work out.” how so??? just because you (or anyone else) say it so does not make it so.

You have roughly $3 trillion in revenue. If you don’t want to cut spending, then you have to borrow $3 trillion in Treasuries, and that I don’t think that the markets can absorb that much borrowing.

Posted by ReformerRayNovember 21, 2008 at 9:56 am

Everybody else except Twofish seems to agree that we are in a financial panic of gigantic proportion – that nothing like this has ever been experienced in recorded history.

Because I think Twofish is wrong, I think drastic changes in U.S. laws are the proper course of action.

Posted by ReformerRayNovember 21, 2008 at 10:02 am

I submit ideas for action to this website because I hope to receive serious criticism of the proposal. I appreciate Twofish’s attempt to provide that critique – primarily because no one else will do it.

On the other hand, surely my ideas have more problems other than “the Congress will not accept it”. Come on, Twofish, spend a little more time on the issues and come up with an answer to how either of my proposals will harm the U.S. or can be improved.

Posted by ReformerRayNovember 21, 2008 at 10:07 am

lb: i really appreciate your contrarian spirit 2fish but sometimes i wonder why you continue to throw cogs into people’s ideas — is it to help them see the issue in a different way or is it to intentionally discourage anything that might upset the status quo?
It has to do with my background as a physicist. What happens is that when you come up with a new or an old idea, you have to subject it to what can best be described as an intellectual gladiatorial match, with the notion that any idea worth keeping will survive this sort of combat

Twofish has exactly the right perspective. He just needs some help.

We need to focus on a critique of every idea presented in this forum.

Posted by ReformerRayNovember 21, 2008 at 10:16 am

Twofish responds:
ReformerRay: The above posts says that the solution to our current problem is to pass a law which prohits enforcing existing contracts as written in the Courts in the U.S. without an modification of some of these contracts.
There is already a law like that. It’s called the Bankruptcy Code. People declare bankruptcy to keep creditors from enforcing contracts and seizing property”.

The difference between the current bankrupcty code and my proposal is that bankrupcty today is initiated by the investor. My proposed law will require action by the courts, independent of the wishes of the investor. Quite different.

Posted by ReformerRayNovember 21, 2008 at 10:19 am

My mistake. Foreclosures are initiated by the investor. Bankruptcy is intitiated by the person owning debts. Currently, the local court does not act until one or the other petitions the court.

Posted by ReformerRayNovember 21, 2008 at 10:21 am

I sure type a lot of half-truths in my haste to try to add correctly. The change in the numbers is very frustrating.

My proposal says that the courts will not act until they receive a petition. My proposal says they will now act in a different way than formerly.

ReformerRay: Currently, the local court does not act until one or the other petitions the court.

And if you have a situation in which both parties benefit by not going to court (and this happens a lot), then they can work it out by themselves.

One huge problem with mortgages is that it’s not clear who the mortgagee is supposed to renegotiate with. If you have the mortgage sold and resold to a hundred different people, then who do you ask forgiveness from?

I’ve been looking a lot at Islamic banking and thinking of some of the techniques used there would have made the system more stable.

ReformerRay: My proposal says that the courts will not act until they receive a petition. My proposal says they will now act in a different way than formerly.

My one view is that you probably don’t want to leave too much in legislation and if you want to give judges the power to force a mortgage reset, you probably ought to just let the judge do anything that they think is fair.

The trouble with this is that this is not going to happen before January. Democrats tried to give bankruptcy judges the power to reset mortgages and the Republicans said no. This might change under the Obama administration. It really is an issue of political strategy. You have a limited amount of political capital and the question is what do you spend it on.

Posted by ReformerRayNovember 21, 2008 at 1:40 pm

“One huge problem with mortgages is that it’s not clear who the mortgagee is supposed to renegotiate with. If you have the mortgage sold and resold to a hundred different people, then who do you ask forgiveness from?

Precisely. Which is why I resolve the issue by requiring the court to decide whether or not a payment of 70% of the current mortgage could be sustained by the home occupier. In my scheme, the investors is not consulted, he has no right to interfer with what the law says.

Posted by ReformerRayNovember 21, 2008 at 1:43 pm

“My one view is that you probably don’t want to leave too much in legislation and if you want to give judges the power to force a mortgage reset, you probably ought to just let the judge do anything that they think is fair.

My views is exatly the opposite. By setting in law what will be done, you insure fairness to all. No need for judges to decide how much a mortgage should be reset. Either the occupant can pay at a rate that will hopefully give the investor a better return over the life of the mortgage, or he cannot.